Using a HELOC for a major purchase

Looking to pay for a big-ticket expense like a wedding, major medical procedure, or new kitchen appliances? If you’re a homeowner, you may be able to reach your goal by borrowing against your home equity, which is the amount you truly own on your home. It’s smart to research this option because a home equity line of credit (HELOC) often comes with an interest rate and monthly payment amount that could be lower compared to other kinds of loans.

If you’re unsure how much you need to borrow, that’s fine. A home equity line of credit, or HELOC, is a type of loan that allows you to borrow just what you need. In certain scenarios, a HELOC could be a smart move to get cash to cover your major purchases. 

Let’s look at how a HELOC works and why it could make sense to use one for big expenses. 

What is a major purchase loan?

A major purchase loan is an amount of money that you borrow for a transaction that’s typically far outside limits of your everyday budget. For instance, you may need a large amount of money to replace your HVAC system. 

Other types of major purchases you could use a home equity loan for include:

• New appliances or electronics—upgrade your fridge, computer or entertainment system 

• Old or worn furniture, rugs and other home furnishings

• Medical expenses like surgeries that may have resulted in big bills

• Elective medical procedures that may not be covered by your healthcare plan

• Family planning and fertility treatments such as IVF

• A large wedding, family reunion, or other major life event

How does a HELOC work?

A HELOC is a type of revolving debt, similar to a credit card. HELOCs are mortgages, and your home guarantees the loan. 

How a HELOC works is that the lender approves you for up to a certain loan limit and you could borrow up to that amount. It’s not a one-time loan. As long as you have available credit, you could borrow again. One way to free up available credit is by making payments against your balance.

To determine the amount you could borrow, lenders will look at two factors: your home equity and how much you still currently owe on your mortgage. 

Since a HELOC is a mortgage, it’s a second mortgage if you still have a balance on your first mortgage. Lenders will look at the amount you owe on your first mortgage and home value to figure your loan limit. You’ll only be able to borrow up to a certain percentage of your home’s value.

This limit is called CLTV or combined loan-to-value ratio. If the lender’s CLTV limit is 80%, then between your first mortgage and your new HELOC, you can only borrow 80% of your home’s value.

Let’s say your home is currently worth $500,000 and you still owe $150,000 on your first mortgage. With an 80% CLTV limit, your maximum HELOC loan limit would be $250,000.

$250,000 (HELOC) + $150,000 (mortgage balance) = $400,000 (80% of home’s current value)

If you qualify for this HELOC and you’re approved, you’ll start with a draw period. This is a few years when you can borrow, repay, and borrow more, up to your credit limit, as often as you like. The draw period is convenient because sometimes you don’t know much money you’ll ultimately need.

Some lenders may also require that you draw a minimum amount initially. 

Benefits of using a HELOC for major purchases

Two main benefits of using a home equity loan for a major purchase are:

• Potentially bigger loan amounts compared to other options

• Potentially lower interest rate compared to other options

HELOCs are secured loans. That means your home is collateral for the loan (if you don’t repay the loan, you could lose your home). Secured loans are a lower risk for the lender, so they often come at a lower rate for borrowers. 

HELOC vs personal loan for major purchases

An alternative to a HELOC is a personal loan. Understanding the in and outs of these two types of loans will help you figure out which one is your best choice. 

Interest rates

Personal loans and HELOCs may come with fixed interest rates, which stay the same, or they might have variable interest rates, which could go up or down. The rate you qualify for will depend on different factors like your credit profile and any collateral you offer. 

Flexibility

HELOCs let you borrow again and again up to your loan limit during the draw period. With personal loans, you borrow one lump sum one time. 

Collateral

With a HELOC, your home is collateral—your promise you’ll pay back your loan. Personal loans may not require collateral if you qualify based on your credit standing and financial profile. 

Approval process

Both personal loans and HELOCs require you to go through an application process. With personal loans, most lenders look at information like your credit history, income, and any current debts you owe. With a HELOC, a lender will consider your home value (some may ask for a home appraisal) in addition to your credit history and financial situation. 

What's next

• Estimate your home equity. Knowing how much home equity you may have will help you to determine whether you have enough to qualify for a HELOC. A real estate website could give you a ballpark of your home’s value. Compare that to the balance you owe on your mortgage.

• Check your rate. Talk to a lender who will do a soft check on your credit and let you know what rate you might qualify for. That will help you figure out how the loan could fit into your budget.